Effect money supply has on balance of payments position

[maz1987]

According to Ch 18, 6.1, an increase in the money supply causes a reduction in domestic exchange rate. It gives three reasons:

1. some of the excess money will be spent on foreign assets, which will increase the supply of domestic currency and thus reduce the exchange rate.

2. interest rates will fall due to the increase in money supply, which means the demand for domestic assets will also fall, and hence the demand for domestic currency will fall.

3. speculators expect domestic currency to fall, so they sell the domestic currency and buy foreign currency.

It then says that all of these will result in an improvement in the balance of payments.

What I don't understand is surely each of those three points will principally lead to a worsening of the balance of payments position.

1. if excess money is spent on foreign assets, the balance of investments will get worse:

2. if interest rates fall, then foreign deposits will appear more profitable, and so there will be a worsening of the balance of other financial flows.

3. if speculators buy foreign currency, then that foreign currency may be used to purchase goods/services/investments outside of the country.

Why aren't any of these points discussed?

Thanks

 

[Charlie]

When I studied economics (before the days of the textbook), the notes specified that the term "balance of payments" sometimes referred to different things.

One interpretation is the current account (effectively exports minus imports), and I think this is what they are referring to here, which is why they don't mention the capital or financial accounts

 

[freddie]

I think it's also a matter of timing. Initially, when interest rates fall, there will be a net outflow of savings, so the demand curve for the currency shifts to the left and/or the supply curve shifts to the right. If the exchange rate remained the same, then there would be a deterioration in the overall balance of payments position (which would necessitate central bank buying of the currency to maintain its value). However, in a floating exchange rate system, the excess supply of the currency will cause it to fall. This will self-right the overall position (so that supply = demand) and will, as Charlie says, particularly help the current account position.

 

[maz1987]

Thanks for the answers.

I agree that it's a matter of timing.

Maybe the way in which the increase in money supply comes about has something to do with it? If we look at just the first point, the central bank increases the money supply, which means there is more money in circulation. I imagine this will have arisen due to the bank drawing on reserves. This causes an increase in the balance of payments (+) which is equal to the increase in money supply. Some of the excess money is then spent on foreign assets, which is an outflow (-). But since it's only some of the money, it's doesnt bring the balance back to as it was.

Then, with the increase in domestic currency on the foreign exchange market, the exchange rate falls, resulting in an increase in payments for exported goods and services (+).

Overall this ends in an increase in the balance of payments position.

Is that logic flawed?

edit: Incidentally, if the increase in money supply is caused by banks decreasing their liquidity ratio, and thus allowing to create more credit, does this appear on the balance of payments sheet?